Question

Question 1 (15 marks) Your company poloy to invest sn assets with a marmun payback 012 years Tho company poley aiso makes provision to use the Net Present Value (NPV) as another method to salech proyects Only 5 nvestment with a postve NPV will be seleoted You heve been suppled wth the followng data regarding two mutualy oxclusve investment opportunses Project Alpha Project Beta inhal Cash Expenditure (50,0001 (50,000) Net Cash Flow Year 1 25,000 10,000 Year 2 10,000 20,000 14,000 Year 3 16,000 26,000 10,000 Year 4 Estmated resale value at 12 13 10,000 10,000 the end of year 4 9 20 2 27 2 Notes The cost of capital is 10% Ignore tax . . Reguired. 1 Calculate the Payback penod tor both investments and based on the company's polcy select a project 2 Calculate the net present value (NPV) of both projects and taking the company's polcy into (10) consideration select a project TURN OVER

Answer 1

1. Calculation of Payback period for both investments

Project Alpha

Initial cash outlays is 50000

Year	Annual Cash Inflows	Cumulative Cash Inflows
1	25,000	25,000
2	20,000	45,000
3	15,000	60,000
4	10,000	70,000

From the above table it is clear that payback period shall lie between 2 to 3 years. Since upto 2 years a sum of 45,000 shall be recovered, balance of 5,000 shall be recovered in the part (fraction) of 3rd year computed as follows:

= 15000 / 5000 = 1/3 rd year that is 2 years & 4 months

Thus, Total cash outlay of 50,000 shall be recovered in 2 years & 4 months.

Project Beta

Initial cash outlays is 50000

Year	Annual Cash Inflows	Cumulative Cash Inflows
1	10,000	10,000
2	10,000	20,000
3	14,000	34,000
4	26,000	60,000

From the above table it is clear that payback period shall lie between 3 to 4 years. Since upto 3 years a sum of 34,000 shall be recovered, balance of 16,000 shall be recovered in the part (fraction) of 4th  year computed as follows:

= 26,000 / 16,000 = 1.625 month that is 48.25 days ( 1.625 * 30 days)

Thus, Total cash outlay of 50,000 shall be recovered in 3 years & 48.25 days

Decision : As per the company policy, Company will not select both projects because both projects pay back period is more than 2 years while company's policy to select a project is maximum upto 2 years payback period.

2.  Calculation of Net Present value of both project -

Project Alpha & Beta

Period. A	Annual Cash Inflow of Alpha B	Annual Cash Inflow of Beta C	Present Value Factor @ 10 % D	Present Value Of Alpha E = B * D	Present Value of Beta    F = C * D
0	50,000	50,000	1.000	(50,000)	(50,000)
1	25,000	10,000	0.909	22,725	9,090
2	20,000	10,000	0.826	16,520	8,260
3	15,000	14,000	0.751	11,265	10,514
4	10,000	26,000	0.683	6,830	17,758
4 (Resale Value )	10,000	10,000	0.683	6,830	6,830
Net Present Value				14,170	2,452

Decision : As per NPV Method Company's policy to select a project with a  positive NPV. The NPV of both Alpha & Beta is positive, But NPV of Project Alpha is more than the Project Beta. So, Company select the Project Alpha.